Nick’s Novelties, Inc., is considering the purchase of new electronic games to p

Question

Nick’s Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $672,000, have an eight-year useful life, and have a total salvage value of $67,200. The company estimates that annual revenues and expenses associated with the games would be as follows: Revenues $ 260,000 Less operating expenses: Commissions to amusement houses $ 90,000 Insurance 36,000 Depreciation 75,600 Maintenance 50,000 251,600 Net operating income $ 8,400

1a.

Compute the pay back period associated with the new electronic games.

1b.

Assume that Nick’s Novelties, Inc., will not purchase new games unless they provide a payback period of 10 years or less. Would the company purchase the new games?

2a.

Compute the simple rate of return promised by the games. (Round your answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)

2b.

If the company requires a simple rate of return of at least 5%, will the games be purchased?

1a.

Compute the pay back period associated with the new electronic games.

Explanation / Answer

Cash flow each year = 8400 + 75600 = 84000

Payback period = Yera up to which cummulative cash flow is negative +(Cummulative cash flow of that year/cash flow of next year)

cummulative cash flow up to year 6 = - 672000 + (84000 *7 ) =-84000

cummulative cash flow up to year 8 = -672000 + (84000*8) = 0

So payback period = 8 years

1b)Yes .as payback period is lower than expected,

2a) = simple rate of return = 8400 /672000 = .0125 or 1.25%

2b) No as simple rate of return is lower than expected.

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